Dr Elder designed SafeZone to eliminate the "noise" component of a
trend and hopefully avoid having stops shaken out by that noise. He uses a 22-day
Exponential Moving Average to define
the trend, but I prefer a longer (63-day) exponential moving average.
Elder then calculates directional movement in a similar fashion to Welles Wilder's
Directional Movement System and applies a
multiple of between 2 and 3 to determine the trailing stop.

Safezone stops are primarily used to time exits from a trending market.
Use the exponential moving average to determine the trend and select the Safezone
long or short option.

Exit long positions when price crosses below the Safezone stop.

Exit short positions when price crosses above the Safezone stop.

Safezone cannot be used to signal entries as with some stop-and-reverse systems.

Example

The RJ CRB Commodities Index late 2008 down-trend is displayed with Safezone
(short, 22-day, multiple of 3) and 63-day exponential moving average used as a
trend filter. Entries are taken when price makes a new 5-day low while below the
moving average (or 5-day high when above the MA).

Mouse over chart captions to display trading signals.

Go short [S] when price is below Safezone and closes below the 63-day exponential moving average

Exit [X] when price crosses above the Safezone Line

Go short [S] when price makes a new 5-day low while below the 63-day MA

Exit [X] when price crosses above

Go short [S] when price makes a new 5-day low while below the 63-day MA

Exit [X] when price crosses above

Go short [S] when price makes a new 5-day low while below the 63-day MA

Exit [X] when price crosses above the Safezone Line

No long trades are entered while price is below the 63-day exponential
moving average, nor short trades while above.

The difference is that you can have both +DM and -DM on the same day. If
there is an outside day then
both calculations will be positive. For an
inside day both calculations are zero.

Directional Movement Days

Calculate the number of days with +DM in the selected period; and the number
of -DM days. Elder uses the same selected period for Directional Movement as he
does for the moving
average, but there appears to be no reason why this could not be varied.

When the Trend is UP

Calculate -DM Average:

Sum of -DM for the period / Number of -DM days

Then calculate the Stop Level for today:

Today's Stop = Yesterday's Low - 2.5 * -DM Average

To delay/prevent the stop from being lowered, use the maximum of the last 3
days' stops.

When the Trend is DOWN

Calculate +DM Average:

Sum of +DM for the period / Number of +DM days

Then calculate the Stop Level for today:

Today's Stop = Yesterday's High + 2.5 * +DM Average

To delay/prevent the stop from being raised, take the minimum of the last 3
days' stops.

Note: We use a multiple of 2.5 in the above example, but any multiple
between 2 and 4 is acceptable.

Stops are less likely to move lower during an up-trend (or higher during
a down-trend);

SafeZone does not assume that the trend has changed every time that your
stops are hit; and

SafeZone uses Directional Movement rather than ATR as a measure of
volatility. This is an excellent concept. It attempts to isolate counter-
trend movement as the risk factor when following a trend and removes the
other irrelevant component of volatility (movement in the direction of the
prevailing trend). A runaway trend (or blow-off) may show little or no
counter-trend movement, meaning that stops move tighter as the trend
accelerates into a blow-off.

Potential weaknesses:

SafeZone fails to adequately distinguish between counter-trend movement
and movement in the direction of the prevailing trend — at the start
of a trend or if the trend reverses within the selected time period. All -DM
and + DM is treated equally, whether the trend is up or down, giving an
incorrect reflection of counter-trend movement.

The relatively short time period over which directional movement is
calculated may not adequately reflect potential counter-trend movement.

SafeZone relies on an exponential
moving average to indicate trend direction, introducing some lag. There
is nothing, however, to stop the trader from substituting another trend
indicator in place of the moving average.